Note: Descriptions are shown in the official language in which they were submitted.
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METHOD AND SYSTEM FOR FINANCIAL ADVISING
CROSS-REFERENCE TO RELATED APPLICATION
[0001] This is a non-provisional application of pending United States
provisional
application serial number 60/530,144, filed December 17, 2003, by David B.
Loeper, titled
"Method and System for Providing Investors Financial Planning Advice, Giving
Consideration
to Individual Values, Without Unnecessary Sacrifice or Undue Investment Risk
with Accurate
Confidence Levels," and is a continuation-in-part of co-pending U.S. patent
application serial no.
09/916,358, filed 7/27/01, by David B. Loeper, titled "Method, System and
Computer Program
for Auditing Financial Plans," which is a non-provisional of United States
provisional'
application serial number 60/221,010, filed 7/27/00, by David B. Loeper,
titled "Method, System
and Computer Program for Auditing Financial Plans; and is a continuation-in-
part of co-pending
U.S. patent application serial no. 09/434,645, filed 11/5/99, by David B.
Loeper, titled "Method,
System, and Computer Program for Auditing Financial Plans," which is a non-
provisional
application of U.S. Provisional application serial number 60/107,245, filed
11/5/98, the entirety
of each of which applications are incorporated herein by reference.
FIELD OF THE INVENTION
[0002] ' ' ' This invention relates to the field of financial services, and
iwparticular to a new
method, of,financial advising:
BACKGROUND OF THE INVENTION
[0003] The field of financial advising includes various best practices. These
best
practices include identifying a client's financial goals (e.g. desired
retirement age, desired annual
income. at retirement, desired vacation budget in :retirement, desired estate
value at death., etc..).,.
In some application of general industry practices, but not all, clients are
also asked to rank the
stated goals in relative order of importance. Generally accepted "Best
practices" also include
identifying the client's risk tolerance and creating an investment allocation
aimed at producing
the highest return for the client's risk tolerance and then based on that
allocation's expected
return, calculating the savings needed to achieve the client's goals. In a
conventional approach,
CA 02540003 2006-03-22
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to determine the client's risk tolerance a financial advisor uses a risk
tolerance questionnaire or
asks the client about their tolerance for investment risk defined by various
mathematical methods
like standard deviation, semi-variance or more commonly the largest level of
annual portfolio
losses with which the client could tolerate. This risk tolerance inquiry may
be more nuanced,
such as attempting to determine the amount of assets or percentage of value of
a retirement plan
that the client is willing to put into assets of various risks. Whatever
method of attempting to
identify the client's risk tolerance is used, the result of this inquiry is
then used in recommending
an allocation and related investments to an individual. Often, investors are
advised to accept a
risk tolerance that is at or near the client's maximum endurance level for
losses in their portfolio
value.
[0004] Often the allocations are tested using a Monte Carlo simulation based
on
assumptions of the capital markets, samples of historical data, or both. The
results of these
simulations normally are used to convey a confidence level and/or a percentage
risk of failure to
achieve a desired income level, assets at retirement or any other of the
client's identified goals.
[0005] In other approaches, such as wealth management, the client may define
their risk
tolerance and goals, and the advisor may provide advice regarding asset
allocation relative to
those risks and goals. Often, the financial advisor has the capability of
running Monte Carlo
simulations of future returns of various financial plans. These simulations
can provide results
which include a confdence level and therefore either an.implicit or explicit
percentage risk of
failure to achieve a desired. income level; assets at retirement, ending
estate value, or other goals.
As before, the.client may be advised to allocate their assets~in the asset
classes modeled and to
invest in a variety of inanaged.or unmanaged portfolio choices. Advisors may
advise the client
that actively managed investment alternatives can exceed the performance of
the asset classes
themselves (i.e. that they can outperform the market). Often, the fact that
such actively managed
investment alternatives also carry the risk of materially underperforming the
market may not be
adequately coriveyed.to the. client by the advisor, or such risk may simply
not be adequately , , ,
understood by the investor, or the advisor and that uncertainty is not
normally considered in the
confidence calculation .
[0006] Typical disclaimers used in the industry, which are in significant part
intended to
provide legal safe harbor to the advisor (e.g. "past performance is not a
guarantee of future
results"), may not adequately convey to the client the nature of the risk in
actively managed
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investments. This is because normally the confidence calculation was based on
the uncertainty
of asset class returns; but actively managed portfolios may equal, exceed or
under-perform their
respective asset classes thereby introducing additional uncertainty absent
from the confidence
calculation. Therefore, what that confidence number means may or may not be
fully understood
by the client, or the financial advisor for that matter.
[0007] Furthermore, current approaches often involve periodic reviews of the
performance of the client's portfolio. As part of the review the client may be
provided with a
chart, graph or other representation of how their portfolio has performed
relative to the various
capital markets (i.e. the client's optimal allocation to various asset classes
for their risk
tolerance). If performance was lower than expected or assumed by the advisor
in the original
consultation, the client maybe advised to change investment managers, wait for
a more
favorable environment for the manager's "style" or perhaps increase the amount
contributed to
the portfolio. Alternatively, the client may be advised to eliminate one or
more of the lowest-
ranked goals. If, on the other hand, performance was better than expected, the
client will
typically not be advised to reduce the amount contributed to the portfolio,
even if such a
reduction based on the superior performance is possible (i.e., maintaining the
original "risk
tolerance" level).
[OOOi3] Thus, there is a need in the industry for a new method of financial
advising that
eliminates.the substantial uncertainties assoeiated~with,investing the
client's assets inactively.
managed investment alternatives; does riot~position clients ~at their
maxirxiurri tolerance for risk if
there are more appealing choices the client could make that enable them to
have sufF~cient .
confidence of achiev'irig the goals they value arid thus eliminates the
aforemeritioned~difficulties
associated with conveying such risks to the client. Furthermore, there is a
need to provide clients
with periodic feedback that does not simply chart how their portfolio has
performed relative to
the market, but rather provides clients with a practical understanding of the
concrete impact that
the perforrriance of their portfolio has had their desired goals. There is
also a need for a more
nuanced approach to evaluating client goals, which comprises more than a
simple linear ranking
of goals, but rather which interrelates all of the client's goals so that the
client can make more
informed and satisfying choices about their goals in light of the performance
of their portfolio.
As a result, the inventive system will be more highly valued by clients
compared to current
approaches.
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SUMMARY OF THE INVENTION
[0009] The method of the invention is directed to applying a new method of
financial
advising that is more appropriate and more highly valued by individuals. The
advising discipline
includes a new method of identifying and assessing not only the client's
goals, as in traditional
services, but also identifying and assessing the price that the client is
willing to pay in one goal
to "buy" another goal (or portion of a goal) that is valued more highly. The
method also includes
a means of modeling the uncertainty in future markets so that represented
confidence levels can
be easily and fully understood by the client.
[00010] The method includes a means of using probability analysis to define
the balance
between too much uncertainty and too much sacrifice. Thus, the method combines
mathematical
market simulation with the profiling of the client's goals, and the balance
between too much and ,
too little risk, to produce a package of goals and an investment strategy that
balance the desire to
have sufficient confidence, avoid unnecessary risk, yet make the most of the
client's lifestyle and
do so in a manner that is easily understood by the individual investor. Thus,
Monte Carlo
simulation and/or historical market analysis can be used to model marlcet
uncertainty in a manner
that provides the client with a balance of sufficient confidence yet that also
avoids undue
sacrifice to their goals. . . . .
. . [00011] . . . Further, the method includes investing exclusively in
passive.investments, for . .. .
. ' which it is possible to.mathematieally prove in all material respects risk
of~.underperforming or . .
outperforming the targeted asset allocation. This, is unlike actively managed
investments, which ~ , . '
carry the risk of material uncertainty of underperfonning or potentially
outperforming the asset
allocation strategy.
(00012] The method further comprises a periodic review and reanalysis of the
client's
goals. Quarterly reprioritization of goals can be performed, to eliminate
outdated goals or goals
.that have become~unimportant for any reason, and to add new goals. The
periodic review. and : . ~ ~ .
reanalysis also includes reviewing value of the client's portfolio to ensure
that it remains within
the "comfort zone," i.e. the balance between insufficient confidence and too
much sacrifice to
one's lifestyle.
[00013] By properly assessing the client's goals and their relative weighting,
both
unacceptable sacrifice and insufficient confidence can be avoided. The proper
relative weighting
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of goals, in accordance with the client's subjective assessment and the
advisor's interpretation of
that assessment, is important in providing advice that minimizes any sacrifice
as perceived by the
client. A recommendation should include a target value for each goal not worse
than the
acceptable value and not better than the ideal value. A recommendation under
this method of
financial advice will have rational, sufficient confidence yet avoid excessive
sacrifice to one's
goals. Clients are preferably provided with a range of future portfolio values
that would provide
an acceptable range of confidence. Recommendations are reviewed periodically
for changes in
client's goals, changes in priorities among client's goals, and whether the
risk of unacceptable
outcomes has become too high (i.e. too much uncertainty which requires new
advice about the
choices the client has to bring the confidence level back into the "comfort
zone", or whether the
performance of the portfolio has brought them to the point of having choices
to increase goals or
reduce risk). Because of the wide range of uncertainty in capital markets and
changes to a
client's future goals (in most reasonable probability simulation methods, a
client may have an
equal chance (i.e. 1 in 1000] at being broke in just a few years or dying with
a mufti-million
dollar estate based only upon the uncertainty of asset class returns,
exclusive of the uncertainty
of active investment results relative to the markets and excluding the
likelihood of future changes
to client's goals) and therefore the notion of being able to have certainty to
avoid an
unsatisfactory result is erroneous. Also, attempting to provide the highest
confidence level
possible, can bnly come at; the price~.of .compromising client's. goals and/or
accepting more, . . _ , , , .
investment risk which contradicts.the notion~of ayoidirig unnecessary
sacrifice to the client's, .
lifestyle. Ii1 essence, in the absence of a reasoned acceptable.range of
confidence (i:e. attempting
~to get to the highest confidence level possible) no amount of conservatism
(sacrifice) is too
much. Therefore, this method embraces and manages the uncertainties of the
future to provide
continuous advice about the best choices a client can make about their
lifestyle as well as the
optimal acceptance and avoidance of investment risk in light of the
uncertainties of the future,
', y(not only in,the markets, and.not only,by avoiding the added uncertainty
of active investments, ~ .
but also the uncertainty of the client's desire and willingness to change
tlieir goals or priorities
throughout their lives as may be desired, or as may be necessary to obtain
reasoned confidence,
based on how the capital markets performed.) This method accomplishes this
balance of the best
choices based on what is currently known, what is currently planned to be
desired, and
reasonable confidence considering the effect of the uncertainty of future
asset class returns on the
CA 02540003 2006-03-22
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client's lifestyle and their willingness to modify their goals. While
traditional best practices
attempt to be "right" about where a client may end up falling in the wide
range of market
uncertainties (assuming they do not change their goals and their active
portfolio implementation
doesn't under-perform the asset classes) the reality of the wide potential
extremes of outcomes
sets up financial advisors and their client's for a continuous stream of
surprises without a means
of taking a determined course of action based on random market events. When
short term market
environments produce disappointing results in traditional advising methods,
the typical first
course of action, is inaction (i.e. wait because we hope in the long term
things work out). If short
term market environments or fortunate active management selection produce
unexpectedly
positive results, traditional best practices normal action is again inaction,
merely celebrating the
random fortunate outcome. By contrast, the present method of financial
advising defines specific
values in advance where new advice would be required (if the clients goals and
priorities remain
unchanged) allowing client's to prepare for and know what prudent
modifications in terms of
reducing or delaying goals (dr accepting more investment risk) make sense
based on what has
happened in extremely poor environments and where client's have the choice to
increase a goal
or have the goal sooner, or reduce investment risk where results are
exceptional, in either case
requiring determined action of new advice needing to be designed. Critical to
this process is the
creation of a confidence range that considers the uncertainties of the
markets, and that the
~, "action. point" or portfolib(s) values) for needing compromising advice is
relatively infrequent ~ '. . . .
(i.e. the client would have little confidence in an advisor if half the tirrie
their advice is to reduce
goals or delay'goals.and half the time increasing goals): Likewise, before
goals:.are added,
moved to an earlier date or portfolio risk is increased, thus setting a new
expectation for the
client, it is also important that there is fairly high confidence the addition
or increase in the goals
will not need to be compromised again at some future date if they remain
unchanged by the
client. Therefore depending on the approach used to calculate probabilities
and how well the
assutiiptions are designed.to calculate the probabilities,
the.preferred.embodiment wouldhave
more than half of random market environments requiring no change, less than
one in five
requiring a compromise and the remaining environments requiring a positive
change to goals, or
reduction in portfolio risk, assuming client goals are unchanged and the
uncertainty of active
investing is avoided. This method accomplishes this by defining the comfort
zone where normal
market environments do not require new advice (unless the client changes their
goals or
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priorities), where particularly poor markets must be probabilistically extreme
to require
compromising advice, and where fairly frequent positive random markets results
in occasional,
but more frequent, opportunities to produce advice about improvements to goals
(or portfolio
risk reduction). Such a relationship with a financial advisor, where things
are normally "on
track", where poor markets are "still on track", where extremely poor markets
have some prudent
advice solutions that are unlikely to be extreme and where occasional
favorable markets have
positive advice improvements, dramatically improves the comfort and confidence
the client has
in the advisor, and the advisor's advice and more importantly about the
client's lifestyle. An
example of defining such a range would be calculating all of the future
portfolio values
throughout the client's time horizon needed to have 75% confidence of
exceeding the client's
currently recommended goals (i.e. 750 of 1000 statistically potential
portfolio results) and the
portfolio values that would have 90% confidence (i.e. 900 of 1000
statistically potential portfolio
results) in exceeding all of the client goals. .
BRIEF DESCRIPTION OF THE FIGURES
(00014] Figs. lr~, to 1C constitute a flow diagram outlining the
method of the present
invention;
[00015] Fig. 2 is an exemplary report,generated in accordance with
the present method;
[00016] ~. .Fig. 3 is an_exemplary goal prioritization matrix
in~accordance~with
.~ ~ the~present
method; ~~ .. ; ~ ~ .. : . : . . . . . ' : : . , . . . : . . . .
~ . . . . . . :. . . . , . .
.[00017] Fig. 4 is an exemplary report.,generated .in accordance .with.
~ the present.method; .
[00018] Fig. 5 is an exemplary chart generated in accordance with
the present method. .
DETAILED DESCRIPTION
[00019] , A new method for financial advising is disclosed with the goal of
finding a . .
balance for the:client between vnsufficient confidence (i.e: too much
uncertainty) and v ~ ' ~ '
unnecessary sacrifice. Current techniques attempt to identify the client's
maximum tolerance for
risk, and then to optimize asset allocation based on that maximum risk,
without consideration of
whether such risk is warranted. The client is periodically advised of the
status of their portfolio
based on actual performance of the market. Typically, this status review
consists of a recitation
of the performance of the client's portfolio compared to the market. Less
often, the client is
7
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provided with an updated % risk of not achieving their stated goals, or
current probability of
"achieving" goals (which is actually the chance of exceeding, but rarely is
disclosed as such). If
actual performance of the client's investment portfolio is poor, the client
will usually be advised
to stick to their long term plan in hope that things work out in the long term
or less frequently to
increase contributions to the portfolio or to eliminate one or more of their
low-ranked goals.
Alternatively, if performance is better than expected, the client may be
advised to make no
changes (even if it would be possible for the client to contribute less, while
still maintaining the
same risk of exceeding their investment goals).
[00020] The present method is intended to help the client make the most of the
one life
they have, by confidently achieving the goals the client uniquely values,
without needlessly
sacrificing their current lifestyle and by avoiding unnecessary investment
risks. Thus, the
method obtains from clients only that information that is necessary and
material for the advisor
to understand the client's goals. It identifies the ideal dreams of the client
as well as the
acceptable compromises, and the priorities and proportion in amount and timing
among each. It
also avoids unnecessary risk, and provides performance benchmarks that are
practically
understandable to the client (e.g. "buying the beach house.") It further
provides a comfort range
based on a rational level of confidence in performance of the investment
alternatives, thereby
avoiding too much uncertainty as well as too much sacrifice. It provides a
means of working
with the°client to, provide solution's based. on acceptable
coi~prorriises ~to aehieve'prioritized . ' y ~.. ~ : ; . .
goals, and provides the client with an understandable analysis of the progress
made. toward goals, , . ~ .
while allowing the client to change goals or priorities on demand: -, . ', ' .
~ . . . , '. . . ~. ' , . y .
[00021] Thus, the method is used to subject the~client to no more risk than is
necessary to
achieve the client's goals (i.e. no more investment risk than is necessary to
permit the client to
live life in the best possible way while achieving the goals that the client
values most highly or
partially in proportion to other goals).
[00022] ~ Additionally, the method implements a new notion of how each of the
client's
goals interrelate to one another,, and the number of goal achievement
options.that exist depending
on the client's desires. The method comprises organizing a range of goals,
interrelating their
timing (i.e. when each is expected to be "achieved"), and amounts (i.e. the
relative dollar "cost"
of each goal).
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[00023] The method allows the advisor and client to reorient and re-evaluate
goals going
forward as a means for reconfiguring the client's. portfolio and desired goals
for the future. Thus,
based on actual market performance, the client can be advised (or at least
presented with the
option) to change or reprioritize their goals or reduce or increase investment
risk. For example
the client may be advised that their highly valued investment goals can be
achieved simply by. .
delaying retirement for one year (the date of retirement in this case is not a
critically valued goal
of the client), or by dropping the number of annual vacation trips at
retirement from 4 to 1.
Furthermore, the method allows the advisor and client to make slight changes
in goal priorities
that could allow the client to keep a low-ranked goal, even though portfolio
performance has
been lower than normal. This differs from present methods in which advisors
simply advise the
client to "wait for the long term" (i.e. no action) save more money or
eliminate one or more of
the lowest ranked goals when the portfolio performs poorly.
[00024] In one aspect of the invention, an assessment of goals of an investor
is carried out
by a financial advisor. The financial advisor may be an individual, an
organization, or one or
more organizations, and may include the use of programmed computers. The
investor may be
any legal or natural person or group of persons. Typically, the investor will
be an individual or
couple, but could also be an institution that has an investment portfolio and
liabilities it wishes to
fund like an endowment, pension fund, or foundation. The example below is
tailored to financial
advising for individuals or couples. However, 'such pxiriciples may be applied
to investors other
. than individuals;,for example, these principles may be 'applied to charities
seeking proper , v ' .
management of funds or endowments.. In.this example? a financial..advisor
will, obtain certain
information from the individiial~or couple, who will be referred to as the
client.
[00025] Referring to Fig. 1A, the financial advisor may ask the client for
certain
background information at step 105. This information is typically briefer and
easier to obtain
than the type of information typically required in designing a financial plan.
Because of the
arriount of uncertainties in the fiiti~e, the information collected does not
need to be as arduous as
is typical in.planning because there are.many details that are immaterial in
the context of the
overall vast uncertainty of the future. In general, such information includes
broad but not detailed
information about the client and the client's current finances, information
about anticipated future
income of the client, and the like. Information about the client includes such
as age (or ages if
the "client" is a couple), current assets, current income, current residence,
and current expenses.
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Information about future income will be in the nature of assumptions as to
future income from
sources other than investments, such as earned income, Social Security,
pensions and other
sources of resources. Residence is important for calculation the impact of
local taxes, including
state, county and municipal taxes. The nature of this information will vary if
the technique is
applied to investors or clients who are not individuals.. . . _ .
[00026] Having received this relatively straightforward information at step
110, the '
financial advisor now asks the client to identify their goals, as at block
112. Goals typically
include the availability of resources at various times, such as a range of
annual income during
retirement, a desired range of funds in an estate at a particular point, a
range of desires for
anticipated large expenditures, such as educational expenses for a child,
major future purchases
such as a vacation home, a retirement vacation travel budget, a desired estate
value at death, or
any other expenditure of any description. Goals can be relatively serious or
frivolous, and no
accounting between the two is made during the goal identification phase of the
method because
traditional financial planning methods have advisors coaching clients about
being realistic in
goal setting which eliminates the potential for achieving "frivolous" goals
this method of
financial advising would enable. Furthermore, the kinds of goals will vary
between clients. For
example, a childless couple may have no need for an estate or to pay for
education. The advisor
should be careful to elicit all of the goals of the client, including both
common goals and those
that are rare or even uniqhe to the client. The advisor, having obtained the
identity.:of the goals, .
at block.113, then can ask the client to-identify an ideal value of each goal,
as'at step 1~5. ,
Values' of goals can be iri the, forrri.of an ideal retirement age, or ari
ideal number.of annual
vacation trips during retiremeilt. Other values can be in the nature of one or
more~planned cash
withdrawals at one or more defined points in the future, or for recurring
expenses or a future
major expense (e.g. "the beach house"). The value of goals may also include
amounts and
timing of savings to be added to the portfolio prior to retirement. .
[00027] Ideal values bf goals are those .values which the client most prefers
in each ~. v '
separate category, without regard to whether achieving each of those ideal
values is realistic.
The advisor should communicate that the ideal goals need not be realistic, all
taken together. In
general, clients will want to save less, retire sooner, avoid risk, have a
greater retirement income,
and have a larger estate, and the ideal values of goals will reflect these
desires. Any appropriate
verbal formulation may be used by the client and advisor to communicate the
ideal value of each
CA 02540003 2006-03-22
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goal. The ideal value can be expressed variously depending on the nature of
the goal, as noted
above, in terms of timing (ideally as soon as possible) and values (ideally as
much as possible).
The ideal values of goals are received by the advisor, as indicated by block
120, and recorded.
[00028] The advisor can then ask the client to identify "acceptable" values of
each goal, as
indicated by block 125. An acceptable value of a goal will generally the a
smaller dollar value,
such as of annual retirement income, an estate, funding for education of
children, or a large
future purchase or a later date, such as when one retires or a later date for
a large future purchase
that the client would find as acceptable, i.e. they would be satisfied
compromising the goal (or
delaying it) to that level if it were necessary to achieve another goal they
personally valued more.
[00029] It should be noted that the acceptable size or timing of a goal is not
the smallest or
latest bearable or tolerable amount, but rather is the amount that is
sufficient for the client to be
reasonably pleased. When a value represents a time, such as retirement age or
a date of a major
future purchase, to be deemed an acceptable value of that goal, the date must
be sufficiently soon
that the client will be reasonably happy. It will be understood that a variety
of verbal
formulations can be used by the client and advisor to communicate the
acceptable value of each
goal. The acceptable goals are received, as indicated at block 127.
[00030] An exemplary illustration of ideal and acceptable values for a variety
of goals is
shown in Fig. 2, in which the "client" has identified an ideal retirement age
of 63 years, and an
acceptable retirement age'of 68 years: ' Likewise 'the client. has identified
an ideal travel budget
goal,of $25,000 .and an acceptable value of~$Si000. - . ' ' , ~ . . . , ~ ' '
'. , . ~ ' ' . ' .
[00031] _ , . y Upon receipt of.these~vatues; the client is then asked to
provide relative values for
each of the goals, as indicated at block 128. These must be provided in a
numerical form for
purposes of calculation, but can be obtained in verbal form from a client and
then converted to a
numerical form through interpretation by the advisor. The client may be
prompted to provide the
relative value, of for example, achieving an earlier retirement date, versus
their lifestyle once
retired, of increasing, the arriount saved each year.prior~to retirement, of
reducing their travel
budget prior to or during retirement, of reducing the amount of an estate, of
reducing the
maximum amount available for education of children, and the like. For example,
while it may be
acceptable to have a $5,000 travel budget, would it be worth it to you to
delay retirement one
year if it meant you could have a $10,000 retirement travel budget. The set of
relative values
may involve, if done in other methods without the limiting bounds of ideal and
acceptable
m
CA 02540003 2006-03-22
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profiling as in this method, a rather unwieldy large set of questions, which
could be presented in
the format of a questionnaire. But this method, having the constrained bounds
of ideal and
acceptable goals to work from, simplifies the process to merely giving a
relative value contrast
amongst goals, learned by the advisor in a simple conversation or perhaps with
the aid of a
simple goal matrix. , .. . . _ , . . . .
[00032] There are numerous manners of inquiring about such preferences. For
example,
relative weighting may be inquired in a verbal format, such as "Is an early
retirement as
important as, less important than, much less important than, more important
than, or much more
important than, having additional income during retirement?" The questions may
be asked with
quantitative values, such as "Is delaying retirement by five years about the
same as, much
preferable to, somewhat preferable to, somewhat less preferable to, or very
much less preferable
to, having $3,000 less in annual spending during retirement?" As goals are
generally expressed
in terms of timing and monetary amounts, the comparisons will involve relative
weighing of
these types of values. As will be appreciated, this manner of questioning and
of relative
weighing of goals can and will be applied to all of the goals identified by
the client so that a
comprehensive interrelation of goals is developed and will be conceptually
understood by the
financial advisor for him or her to formulate their recommendation for the
client. This
conceptual interrelation will enable the client and financial advisor to
obtain a deeper
understanding of the relative iriiportarice of ~each~of the~clierit's goals
tli~,t is ~sixbstantially more, ~ . ~ . .'~
nuanced than techniques~in the prior art that require the,client simply to
lank goals in ascending
or desceridixig~order. The interrelation can provide insights to the client;
thetriselyes about'the
relationships of goals in a way that they may ilot have previously considered
nor understood.
[00033] Ultimately, a goal matrix is developed, similar to the one illustrated
in Fig. 3, in
which goals are listed on the vertical and acceptable compromises are listed
on the horizontal.
As can be~seen, the matrix can provide an easy visual comparison of each
individual goal against
each other'goal. In the illustrated embodiment, the client has identified that
in order to reduce '
the investment risk in the portfolio, they would be willing to retire later
and/or reduce the size of
their estate. A further analysis shows that, as to the latter two goals, the
client would be willing
to reduce the size of their estate in order to achieve their early retirement
age. Arranging goals in
a matrix allows the financial advisor to determine the relative importance of
each goal compared
to each other goal, which then allows the advisor to propose a recommendation
that provides
12
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sufficient confidence and comfort of achieving or exceeding those goals each
client uniquely
values, without unnecessary sacrifice to their lifestyle and avoids
unnecessary investment risks.
[00034] Alternatively, the financial advisor can use the matrix to identify
lower ranked
(perhaps even frivolous) goals which can be achieved either through a minor
change in the
client's investment allocation (i.e. a minor increase in investment risk) or
only slightly reducing
or delaying other goals. Providing such an additional benefit to the client
will result in
significant customer satisfaction, compared to traditional practices of
profiling the client to be
realistic at the beginning which would ignore what would otherwise be
considered a frivolous
goal, or in simple ranking methods where frivolous goals would be completely
eliminated due to
their low rank.
[00035] The use of a matrix provides an additional advantage, in that it can
point out
apparent contradictions in the client's relative valuations of goals. As can
be seen from Fig. 3, a
contradiction appears in the client's prioritization of retirement age and
estate size. The client in
this example has identified that in order to achieve their early retirement
age they would be
willing to reduce the size of their estate, however, they have also identified
that in order to
achieve their estate goal they would be willing to retire later. The
identification of this
contradiction highlights the many times fine differences exist between goal -
values, and thus can
be used by the advisor and the client to obtain a deeper understanding of the
actual relative
prioritization'of'these goals. Inahe ill~strated~ example,.upon identifying
the.confhct; the advisor . . ; .: .
could ask the client more detailed que$tions about their relative
prioritization of estate. value : .
versus retirement age or if there~are prefezTed values for either.between the
ideal, and acceptable
extremes the advisor may want to consider when designing a recommendation. For
example, .if
delaying retirement by only one year confidently "buys" an estate equal to
what the couple
inherited from their parents of say perhaps $500,000 (far above the acceptable
minimum estate,
yet far below the ideal as well) the client may be willing to make that trade
of delaying
retireriient one year. ~ Likewise, the client may be willing to
~compromise,their estate.below that. . . , .. ~ , .
$500,000 number if many other goals (travel budget, retirement lifestyle,
retirement age etc.)
must be compromised to only acceptable levels to have sufficient overall
confidence.
[00036] After receipt of the relative goal value information, as indicated at
block 129, the
financial advisor uses the matrix to develop a recommendation, as indicated at
block 130. In the
analysis, the ideal and acceptable values of goals are taken as extremes of
each of the goals (i.e.
13
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they are bookends). Each goal has a representative dollar value of achievement
(e.g. cost of the
"beach house," cost of "child's college tuition", both in ideal - the most,
and acceptable, i. e.
adequate). These assembled values along with the advisor's understanding of
the relative
priorities amongst goals are used by the advisor to build a recommendation.
[00037] . The advisor then uses these values and performs simulations of
various model
allocations, and making assumptions about the future performance of the
associated capital
markets. The advisor uses the results of these simulations in combination with
the goals matrix
of Fig. 3 to determine which model allocation will allow the client to achieve
their most highly
valued goals, which goals, if any, will need to be adjusted closer to~their
"acceptable" value, and
which goals can be achieved at or near their "ideal" value. Likewise, using
this method the
advisor can also recommend which lower value goals can be achieved with only
slight
modifications to the values of other goals (e.g. increase pre-retirement
savings by $X to achieve
one more Jamaica trip per year in retirement).
[00038] As will be appreciated by one of ordinary skill in the art, a variety
simulations can
be performed. In a preferred embodiment of the inventive method, the capital
market
assumptions are those based on the assumption that assets in a portfolio will
be invested
passively. As previously discussed, investing in actively managed investment
alternatives
carries a risk of materially underperfornling the relevant asset classes to
which the investment
'belongs: tT~ereby iritrbducing a risk mot.being~ niodeled~if.one uses only
tlie~risk arid return.
characteristics. of the asset classes. Although actively managed irivestmerits
also carry the
:~ potential for returns that are. substantially above those, of.tlie
associated asset class or classes, it is ~ .'
knovsm that any active implementation alas the potential for a wide range of
possible outcomes
(from materially underperforming the market or asset class to substantially
out-performing the
market, and all points in between) thus also carrying and introducing a level
of risk that is
difficult, if not impossible, to adequately predict, and thus can provide
widely varying outcomes
from year to year. Also; in the absence of being able to know this~risk,
any~confidence numbers
presented to the client can be substantially flawed if this additional risk
beyond the asset class
uncertainty was not considered. Saying a client has 82% confidence if
investing in these asset
classes (i.e. passively) may be a reasonably and directionally sound
representation. However,
saying the client has 82% confidence based on the asset classes modeled, then
investing in a
manner that introduces an opportunity for exceeding market results and a risk
of materially
14
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underperforming market results (neither of which were modeled) makes that
confidence number
of questionable value to the client because it can be substantially flawed.
Thus,
recommendations should not include investing any assets in any actively-
managed fund. The
fact that a given fund or fund manager has done better than the markets in the
past is not an
indication that the fund will be more successful in the future. The
uncertainties involved in
investing in any manner other than fully passive investment create a
divergence between the
predicted probability. Rather, the inclusion of actively managed funds in a
recommendation
creates an additional element of uncertainty. Moreover, there is no reliable
model for predicting
this additional element of uncertainty, although one can model potential
impacts of the amount
of uncertainty introduced and based on the confidence and comfort targeted
under this method,
even a small amount of active uncertainty (i.e. well below any actual
historical ranges)
introduces an irrational investment risk that could be avoided. With a managed
fund, one cannot
use statistical techniques to accurately model the risk of underperforming or
outperforming the
market but the possible risk it introduces can conceptually be estimated and
shown to be an
irrational risk this method of advising would avoid based upon a key tenet of
the method of
avoiding unnecessary investment risks.
[00039] By contrast, the use of passive investment alternatives provides a
relatively high
degree of predictability to the forecast simulations. Although such
investments have essentially
no chance of ever'significantly o'utperform'iiig: the
~ssociated~asset~class'or classes, liut likewise . ~ ~ ~ ~.
.they will never m~.terially,underperform.their classes by more than their
expenses which can be
accurately modeled. Thus, passive irivestments,form the basis for.investing
usingaha.present .
method, by avoiding the unnecessary risk of potentially material market under-
performance.
[00040] The model used to simulate market results is preferably one that bears
a realistic
relationship to actual historical market returns. However, a well-designed
model should not
slavishly follow the data available for historical markets. Historical market
data is available for
only a limited period of time,. and only'represents a portion of the outcomes
possible in the ~, . .
future. A well-desig~zed model is valid regardless of shout term market
changes. A model that
slavishly follows market returns, such as modeling based on the most recent
twenty years,
changes each time new data is added. Even for long periods of time, such as 30
years, the
limited historical data the industry has shows that for volatile assets like
large cap stocks, 30 year
returns based on monthly data back to 1926 show a 30 year average return
ranging from 7.17%
CA 02540003 2006-03-22
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to 14.29%. If one uses either of these 30 year results as an input to a
simulation engine, they
would be simulating a 50% chance of doing better or worse than the market has
ever done, which
is statistically erroneous. Such dependence on trailing returns is not
appropriate for a reliable
model of market behavior. Indeed, depending on the time period selected, there
will be
significant variation when a model based on trailing returns is tested against
actual. historical
returns. A model with higher levels of confidence will not be so dependent on
the data. A model
using Monte Carlo analysis is preferred to model the possible future results
to enable the
expansion of the probability that we have not yet seen either the best or
worst the markets may
produce. .
[00041] A well-designed model will show various defined characteristics when
compared
with historical results. Of course,.in conducting such a comparison, it should
be kept in mind
that historical results represent a relatively short period, and a relatively
small number of
potential results. A well-designed model should include results, in such areas
as average return
and standard deviation, at the extremes that fall beyond actual historical
results. For example, at
the 5th and 95th percentiles, simulated results should be respectively, higher
and lower than the Sti,
and 95'h percentile for historical results depending on the number of
simulations being run...i.e.
mathematically the greater extremes will exist in larger number of
simulations, though their
probabilities of occurrence once a statistically valid number of simulations
has been run will be
. . too remote of a probability to be useful in advising ~a'client about.
a.dynamic and changing. set of , ~. . ..
goals end priorities. The best arid worst results should be better and'worse
than the best and. , y , ~ .. ~~
worst historical results. . Otherwise, the simulation would indicate that the
woxst or best ~iossible
results had occurred in the relatively short period of time for which there is
accurate data. The
amount of the variation should depend on the volatility of the asset class.
For example,
simulated results will be very close to real results at the 50th percentile
for Treasury bills, and
will generally be further away from real results as the market becomes more
volatile, such as
sniall~capitalization stocks. Testing should also indicate that.the variation
between the~simulated,
returns and actual returns, at the extremes, is greater in asset classes with
higher volatility. For
example, the best and worst results for small cap stocks are likely to be
significantly better and
worse, respectively, than the historical results. If the model is found not to
predict results along
the foregoing lines, then the model may be found to be unrealistic. The
modeling assumptions
should then be adjusted.
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[00042] Asset classes can include all U.S. stocks, U.S. large capitalization
stocks, U.S.
large capital growth stocks, one or more foreign markets, U.S. mid-
capitalization stocks, U.S.
small capitalization stocks, Treasury bills and bonds, corporate and municipal
bonds of various
maturity, cash, cash equivalents, and other classes of assets.
. [00043] The testing. of the model should take into account variations in
historical markets.
For example, using randomly-selected historical results in the generation of
returns in a Monte
Carlo simulation can.result in obtaining an excessive number of selected
results from either bull
or bear markets. If data from those markets appears excessively in simulated
returns, the
simulated returns can be skewed excessively in a positive or negative
direction. Thus, the inputs
for the Monte Carlo data should be selected so that unusual results, such as
those from the
unusual bull markets of the 1990's, or those from the long bear market of 2000
to 2003, are not
overrepresented.
[00044] Models which are found to predict that an excessive percentage of
outcomes will
be worse than history are inappropriate, as a plan based on such a model is
likely to result in
unnecessary sacrifice to the lifestyle of the client. Similarly, models which
are found to result in
an inappropriately large percentage of outcomes superior to history will
overstate the confidence
that the client can have in the recommendation. Models that fail to account
for fluctuations in
markets (e.g., assuming a constant annual rate of return) will miss
significant risks associated
.. ~'. with market fluctuations and 'completely ignore the uncertainty of
future~markets.
[00045]., y ~ : By employing these simulated return techniques, the advisor
designs ari . ~ . ~ ~ ~y
appropriate xecomxnendation~for the client. In the process bf designing
a~recommendation; the ~.
f nancial advisor tests the effect arid sensitivity to various goals based on
their conceptual
understanding of relative priorities and iteratively works their way to the
best solution among the
goals,.priorities and desire to avoid or tolerance to accept investment risk.
The recommendation
that results will at a minimum fulfill at least all of the acceptable values
and dates of the goals of
the .client while providing as little, deviation as possible from the ideal
values, of those goals that . ..
the client has indicated are most important. The goal matrix is used in this
process. This may be
an iterative process for the advisor, and it may involve the creation of a
number of test plans that
are developed and compared using the goals matrix. While one might be tempted
to create a
testing algorithm, the required inputs would be unwieldy as previously
discussed and the
practical reality that the client's goals and priorities will change
throughout their life anyway
17
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(client's are not clairvoyant) make such an effort a rather useless expense of
energy and lead to a
false sense of precision that is inadvisable considering the vast
uncertainties of the future.
[00046] The financial advisor will develop these recommendations using a
computer '
having various background information relating to the client stored therein.
Thus, the client's
background information will typically be.stored in memory or on some form of
storage medium,,
and a program running on the computer (or a connected computer via a network
connection) will
use the background information in concert with the market simulation
techniques to develop the
recommendation. The recommendation will include a current asset amount, the
time and amount
of all contributions (currently planned) to the portfolio assets, the time and
amount of all
withdrawals (currently planned) from the portfolio assets, and allocations of
assets among one
or more classes of passive investments, which allocations may be constant or
may change at
various times.
[00047] The appropriate recommendation will have sufficient but not excessive
confidence of exceeding a recommended result for each goal, not better than
the ideal value and
not worse than the acceptable value. As previously noted, a recommendation
with better than the
ideal value of a goal is considered undesirable, because it would indicate
that some other goal
has been sacrificed unnecessarily or that the client is sacrificing too much
by contributing more
to the portfolio than is necessary and thus will have less cash available for
present (i.e. non-
reti~rerrlent) use.: If the ideal value of~the.goal has been properly~el~cited
from the client, a target ~ . . ' ~ , ' ,'~ .
better than the ideal value will be ofno or almost.na additional value
orwtility to the client." . : ~ '
.~[00048] ' It will be understood that apart ~of the process of: the
evaluatibrl:under this . . ' .
method is running a series of simulations using appropriate.modeling, as
discussed above. ~It
will be appreciated that appropriate modeling provides superior results...i.e.
does not contain un-
modeled risks. As previously explained, the modeling of capital markets is
preferably carried
out assuming passive investment alternatives. The advisor may rely on prior
testing of capital
market models; or may take the additional step of conducting a, comparison. As
indicated at step .
140, the appropriateness of the model for the particular recommendation may be
tested by
comparing against historical results, using techniques explained in co-pending
U.S. patent
application serial no. 09/434,645, filed 11/5/99, titled "Method, System, and
Computer Program
for Auditing Financial Plans," to David B. Loeper, the entire contents of
which is incorporated
by reference herein. As noted above, if the modeled results differ
significantly from historical
1s
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results at the 50th percentile, or differ inappropriately at the extremes,
then the model must be re-
evaluated and altered to provide appropriate results. This is indicated at
step 145. The
recommendation can then be re-evaluated, and may need to be altered by the
advisor, as
indicated at step 150.
[00049] . The selected recommendation can.then be presented to the client
(step 155) in a
report similar to that shown in Fig. 2, which can be part of a larger report,
in electronic or hard
copy form. The recommendation will include an assessment of the current
confidence level, the
recommended size and timing of goals, recommendations for investment, and a
range of
portfolio values within which it is not necessary to re-evaluate, whether any
changes are needed
based on the market's behavior (identified by the "comfort level" zone in Fig.
2). The portfolio
value "zones" will be discussed further below in connection with Fig. 5. The
recommendation
includes recommended values of each goal, not better than the ideal value, and
not worse than
the acceptable value. Investment recommendations are preferably classes of
assets which are
passively invested (e.g. large cap, mid cap and small cap stocks, foreign
stocks, Treasury and or
municipal or corporate fixed income securities, and cash equivalents).
(00050] The client can review the recommendation, and provide feedback or
question the
advisor about the recommendations for the impact of alternative allocations,
recommended
values between the ideal and acceptable goals, etc.. This could be needed due
to the conceptual
nature of the discussion of relative.priorities.. The~e,reasons may
poirit,out~am error in the data.
. . obtained~as.to the identity of the goals; the ideal,andlor acceptable
values of the .goals, and/or the
. relative values eW bodied in the goal, math. After consultation, the advisor
can make the _ ~ . '.
appropriate~changes, and then repeat the steps above of designing a
recommendation. ~ The
revised recommendation is then provided to the client.
[00051] Using the relative goal-weighting technique, it can often be found
that a relatively
small change in one goal (e.g. increasing retirement age by one year where
client loves their job
and doesn't rriirid ~orking~an.additional year.); can be'sufficient.to make a
significant change in
another goal (e.g. buying beach house 5 years earlier). In general, by
increasing savings during
working years, delaying retirement, and reducing spending during retirement, a
greater
likelihood of EXCEEDING all of the client's identified goals exists. However,
it is amimportant
feature of the present invention that the advisor and client recognize that
such steps involve some
certainty of sacrifice for the client, and that a recommendation that achieves
too high a certainty
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of exceeding all or most of one's goals more goals may not be desirable
because it can unduly
sacrifice current or future enjoyment of the only life the client has.
[00052] Once again, the importance of investing in passive investment
alternatives is
considered key to providing the client with a recommendation that includes an
accurate estimate
of the confidence level being.represented. As previously stated, a reasonable
estimate of the . ,
confidence level can only be provided when both reasonable capital market
assumptions are use
and passive investments are assumed. If the advice to be provided were to be
for investment of
one or more assets in managed funds, or in individual stocks, individual
parcels of real estate, or
other assets that behave differently than the capital markets that were
modeled, then the
confidence being represented to the client will be flawed because the specific
uncertainty
introduced cannot be predicted with certainty, was not included in the
confidence calculation and
therefore cannot be modeled to produce any particular confidence level that
would be
representative. A recommendation of managed portfolios, carries a degree of
unpredictability
that makes them less desirable for use with the present method because of this
uncertainty of
their future behavior (we can reasonably estimate potential market uncertainty
but not how any
one money manager may behave) and the importance of the confidence calculation
being an
reasonable estimate in the value provided in this method (an obvious
contradiction exists if one
is measuring and advising to have sufficient but not excessive confidence but
how one
" . iinplenierits if introduces sari W iknow~b~Ie, effect on confidence that
isn't modeled). . . ~ : ' , . . ~ ,
100053] . . : Figs. 2 and 4 shovci ~an exemplary form used to convey
infoi~nation.regardirig, the .
recomrr~endation to a'client. The. method of profiling the, c]ient's goals
catz be understood by
corilparing~the resulting recommendation for two clients with identical
background information
and ideal and acceptable values of goals, but who have different relative
weightings of those
goals. In the example of Fig. 2, although not shown, the client has
prioritized the following
goals: (a) retirement income, (b) minimum savings prior to retirement, (c)
educating their son
through graduate,~scliool, and (d) inaxirriizing their travel budgetin
retirement. The resulting
reconunendation meets their desired low level of savings, amoral travel
budget, and support of
their son's education, while other goals are compromised much closer to the
acceptable level but
importantly are generally not completely eliminated unless the value to the
client was
extraordinarily low in context of other goals. In the example of Fig. 4, the
recommendation
reflects goals that, although not shown, are significantly different than the
previous client. The
CA 02540003 2006-03-22
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highly valued goals of the client in Fig. 4 are: (a) early retirement, and (b)
a minimum value of
an estate - here, an estate of $1,000,000 (in this client's case their desire
was to not spend
principle and wanting to maintain the real spending power of their portfolio).
The goals are
achieved here by compromising the amount of savings prior to retirement as
well as an increased
investment risk.
[00054] Figs. 2 and 4 also place the recommended, ideal and acceptable values
of goals on
a continuum of comfort assessment. This combined package of the client's life
long goals along
with the recommended investment strategy/allocation to passive investments and
approximate
current portfolio values are combined to calculate those future portfolio
values necessary to have
sufficient confidence (i.e. avoid too much uncertainty) and those potential
future portfolios
values that would place them at excessive confidence (i.e. too much sacrifice
to their lifestyle).
In this example, there are three categories: "uncertain" - where confidence is
deemed too low to
have reasonable comfort about one's ability to live as currently planned and
recommended and
the risk of undesired material changes is therefore too high, and is thus
unacceptable; "sacrifice"
- where there is a certainty of giving up excessive time or current or future
spending and leaves
one with a very high likelihood (i.e. 90°Jo) of leaving an estate
larger than planned at the price of
other goals and/or unnecessary investment risk (volatility of the investment
portfolio); and
"comfort" - which provides an appropriate balance between the risk of too much
uncertainty and
tovo much lifestyle sacrifice:' As shown in Figs. 2 arid 4, the "comfort"
range resides between ~ ~ ~ ' '
75% and 90% confidence.. The recommended values of goals will be soiriewhere
within this ' .. : , ..
''comforf.'~ramge. . The acceptable values of goals normally fall in the
"sacrifice" region, while .
tlie~ ideal values of goals normally reside in the "uncertain" region. While
this is not necessarily
always the case, ideal and acceptable sets of goals that fall in inappropriate
areas offer another
opportunity for the advisor to coach the client about needing to be more
realistic about their
acceptable goals (i.e. if the acceptable falls below the comfort zone) or to
coach the client that
whey can have grander aspirations (i.e. if the ideal goals fall into the
sacrifice zone). As the '.
graphical display shows, there is a range of potential outcomes and targeted
potential portfolio
values where if one's goals remain unchanged there is no reason to be
concerned...i.e. comfort.
This range will of course vary for the particular client.
[00055] The "comfort" or "confidence" values represent the results of the
historical
market analysis andlor Monte Carlo analysis of the relevant capital markets
based on the passive
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investment allocations recommended by the financial advisor. In one
embodiment, 1000 market
environments, both good and bad, are simulated based on thoroughly analyzed
capital market
assumptions designed in a manner to realistically model the nature of the
potential range of
capital market outcomes. The "comfort" or "confidence" level is the percentage
of those 1000
simulations, in which the client's goals are exceeded., . .
[00056] In order to appropriately implement and manage the recommendation
created
using the method as described so far, it is important that the advisor and
client periodically
monitor the effect of the capital market results on the progress being made of
the
recommendation in order to keep the client rationally confident about their
financial future yet
avoid undue sacrifice or capitalize on opportunities to reduce investment
risk. As part of this
monitoring step, the advisor and client can make changes necessary to maintain
a
recommendation within the "comfort" zone throughout its life. This periodic
review is important
because it allows the advisor and client to efficiently react to make
appropriate changes to the
recommendation when actual market performance is outside of the performance
needed to
maintain confidence, and avoid sacrifice. It also allows the client and
advisor to address any
changes to the client's goals or relative priorities among goals that have
occurred since the
previous review period. Thus, for example, where actual market performance for
the period
were worse than required to maintain sufficient confidence, the advisor can
recommend a change
in allbcation, ~an increase in contribution ambux~t, ~r ~a change. iri values
and/or prioritization of ~ .. . ~ ' ' '.
goals in order to inaintain.the~ client within the "comfort" zone.
~orrespondirig changes car;. be'
made where actual market.peiformance forahe.periodwvas better as
well.offeririg~the
opportunity to increase goals, obtain goals earlier, or reduce the portfolio
risk..
[00057] The periodic review advantageously will also capture changes to the
client's
goals, or their ideallacceptable values of those goals. This provides a degree
of flexibility to the
recommendation that corresponds to the natural changes in the client's life
and their financial
and other priorities. ~ Thus, where the client originally identified 'paying
son's education ~ . ,
expenses," as a high priority goal, this goal could be eliminated where, for
example, the son
receives a scholarship or decides not to attend college. Likewise, if the
client is the beneficiary
of a large family estate payout, the Pre-Retirement Savings value could be
changed accordingly.
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[00058] Additionally, even if the client does not add or delete goals, they
will be requested
to review their existing goal matrix to incorporate any changes to the
relative prioritizations of
their goals represented in the matrix.
[00059] Once any/all changes have been identified, a calculation can be made
of needed .
portfolio values necessary for the client to remain in the ",comfort".zone.
These results can be
provided to the user in the form of a graphical display similar to that shown
in Fig. 5, in which
portfolio value is indicated on the vertical axis and client age is indicated
on the horizontal axis.
Again, the "comfort" range is identified in the center, with "sacrifice" and
"uncertain" above and
below, respectively.
[00060] It will be understood, referring to Fig. 5, that the range of
portfolio values based
on the uncertainty of passive portfolio allocation naturally narrows as the
end point of the plan,
and a certain dollar amount, is approached. Thus, the middle range in Fig. 5
represents the
portfolio values that would produce 75% to 90% confidence at each year
throughout the client's
life. This is in contrast to current methods of probability based financial
advising, in which the
range of risk actually expands toward the end point of the plan.
[00061] Using the inventive method, the financial advisor and client are able
to make
periodic adjustments to the client's recommendation in order to ensure it
remains within the
"comfort" zone. The financial advisor will advise the client to review and
change the portfolio if
'~ the value~approaches the edge of, or fates outside of, the:~coriifort zone.
If the markets have : ~. ~ ~.. .
W nexpectedly high returns, such as those from an extraordinarily unusual'bull
market, for a tirrie
. period near the, beginning of the recommendation, the plan assets; or
portfoliovassets,. will.likely
exceed the upper limit for that year (or other time period). Thus, the advisor
can recommend a
change to the reconunendation that would move the plan from the "sacrifice"
zone back down
into the "comfort," zone. Such changes could, for example, include a reduction
in Annual
Savings (Figs. 2, 4), a reduction in portfolio risk, increasing planned
retirement income, etc.
'. ~ Alternatively, if the markets have, returns, that produce portfolio
values less ~thari, the lower limit
of the comfort zone, the advisor would recommend similar changes to the plan
(e.g. a change to
goals or values of goals, increase investment risk or timing of goals) to
place it back within the
"comfort" zone. As previously mentioned, how often such events occur is
controlled by the
target confidence range. If the range were in the middle, say a comfort range
of 43-57%, many
market environments would require significant reductions to goals (nearly
half). Whereas if the
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range is too small, say 80-82%, while negative adjustments would be less
frequent, positive
changes would occur very frequently only with a frequent likelihood of needing
to be reduced
once again in the future. While the specific values of 75-90% are not rigidly
required (obviously
these are dependent on how the capital market assumptions are built as well)
the notion is that
rnarket_behavior driven changes are not frequent and are unlikely to be.very
extreme by . ,
measuring confidence toward a tail of the distribution with the odds tilted in
favor of exceeding .
client goals (clients can change their goals and priorities at any time and is
obviously always
better to get a better understanding of what how they would like to live their
life), and positive
changes to goal recommendations are more frequent than reductions or delays in
goals, and that
positive improvements to recommendations (enhancing recommended goals) are no
more likely
to need to be reduced again later than any recommendation previously made
(again, controlled
by measuring confidence toward the distribution tail that favors odds tilted
toward exceeding the
results).
[00062] Likewise, if there is a bias in the capital market assumptions which
caused the
modeling to be inaccurate, the portfolio value review will tend to reveal such
assumptions. For
example, if the assumptions were overly pessimistic, the portfolio value might
tend toward the
upper limit of the comfort; zone. If the assumptions were overly optimistic,
the portfolio value
might tend toward the lower limit of the comfort zone. Appropriate changes to
the assumptions
' Cam then be implemented. ~.. ' ~ ' ,~ . ~ ~ ' ", y . . . . . . . ~ .. .
[00063] Referring to Fig. ~.B; the step bfmoiiitoring~ lie cui~ent status of
the. . ' y y
recommendation and making appropriate charges is indicated at step 160, while
the step or . ' .
reassessing client goals is indicated at step 165, and the step of preparing
new recommendations
based on those goals and the client's current situation and evaluating the
model used to generate
such recommendation is indicated at steps 130-150. It is noted that the timing
of this periodic
review is not critical, though in a preferred embodiment the review would
occur quarterly.
When an, alteration occurs iri the client's goals or their relative
importance,, as. noted iri block 175,
the financial advisor must obtain the client's new goals and/or their new
relative weighting, as
indicated at step 180. The financial advisor then prepares a new
recommendation for
consideration, incorporating the client's current goals, and develops a
proposed recommendation
based on the modified goal information, as indicated at block 130. A revised
recommendation is
presented to the client (step 155), along with a range of portfolio values
within which the client
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would remain in the comfort zone and would therefore not require reassessment
if goals and
priorities have not changed. If the performance of the markets (and therefore
also the passively
invested portfolios) which cannot materially underperform the markets) is
within the
appropriate range, and the client''s goals have not changed, then the current
recommendation,
with current passive investments, is,used, a5.indicated by step 190. . . . . .
.,
[00064] Providing the client with an assessment similar to that of Fig. 5 is
highly
advantageous to the client because it provides a clear and easily
understandable indication of
progress toward the goals they wish to plan their life around, and clearly
places that progress
within the context of the balance between undue sacrifice and excessive
uncertainty previously
discussed. Using the present method, the client will easily be able to tell,
based on what~has
happened with the performance of the portfolio, when a change in the
recommendation is
required to maintain that balance.
[00065] The present method significantly differs from conventional prior art
methods in
that prior art methods often attempt to assess the risk based merely on a
client's stated
willingness to endure losses in their portfolio or some other mathematical
method. such a
willingness to endure risk bears little or no relationship to whether
accepting such risk makes
sense for what the client wishes to achieve when considering acceptable
compromises to goals
that would enable them to accept less investment risk. Also, using such a
prior art risk
'assessxrierit, tlie.clienf has~no way ofknowing whether or when.~losses
incuired asaime passes are, ~ . ~ ~ ,
sufficient to trigger a review of the tr~dition~.l financial plan. ' ~ ~ v ' .
[00066]. , ~ 'The present 3nethod also differs.from the prior art in that it
employs passive ~'' , '
investments whose potential wide range of future potential behavior can be
relatively accurately
estimated. This is in contrast with typical financial plarming systems which
advocate the use of
actively managed investment alternatives, which introduce a risk that the
client's portfolio may
materially underperform the associated asset classes, and whose future
behavior can not be
accurately estimated. , ' . . . . . . , . . . . . ' . ~ . . ~ , . ~ . . . ~ .
. . . . .: .
[00067] It should be noted that the client should be advised that a
reassessment of the
recommendation is advisable whenever a goal is added/deleted, the ideal or
acceptable values of
an existing goal has changed, or the relative priorities of any of the
existing goals has changed
(step 175). The same is true for changes in background information, such as
where a client
receives a significant inheritance, thereby increasing the present portfolio
balance. Previously
CA 02540003 2006-03-22
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acceptable goals for savings may become unattainable, such as where a client
loses a job and is
therefore forced to save less or when the client receives a promotion that may
make additional
savings less of a burden and thereby enabling more, or greater, or sooner
goals to be modified, or
portfolio risk reduced. Additionally, acceptable and ideal values of goals for
post-retirement
spending.may change if a client is promoted and becomes accustomed to a more
expensive, . . .. . .
lifestyle; a child who was expected to require substantial college tuition
payments may choose
not to go to college or may obtain a scholarship, thereby eliminating a goal
of providing for the
child's education. Likewise, a client may change jobs or careers and decide
that an early
retirement is of less value to then than other goals.
[00068] It will be understood that the process of monitoring the status of the
recommendation and the client's goals and their relative importance preferably
will continue
throughout the duration of the financial advising relationship with the
client.
[00069] The method of providing advice according to the invention can be
generalized. In
a generalized form, a method of the invention is used to provide investment
advice as well as
advice about the best choices about life goals given at least two goals (one
being some targeted
end value or series of spending goals or liabilities, and the other being the
desire to avoid
unnecessary investment risk). In this generalized method, a client may be an
individual,
corporation, or institution. Background information may include a current
portfolio value,
;'curierit, program expenses, and currerrf development eXpenses,~ for example.
~. The. client is ~ . ,. .. . ~ . ~ : .
prompted to identify a spending, or target Eric goal, their tolerance for;
investment risk and their .
desire toavoid inveshnent risk, and identify. both ideal and..acceptable
values for each. ~ The goals ~ . .
may vary depending on the nature of the client. For example, for a charitable
institution engaged
in planning investment of an existing or newly donated sum, the goals may
include levels of
investment risk, a desired annual income for programs, an annual budget for
development and a
desired value of a portfolio at a certain date in the future. The client is
then prompted to identify
relative values of such.goals. A charitable institution rnay weigh a,desire to
engage iypresent . ~ , ,
spending against a desire to have a large sum in the future for a capital
project. A
recommendation under this method appropriate to the client, the goals, the
ideal and acceptable
values of each goal, the relative values of all goals, may then be developed.
As with other
recommendations, the investments must be passive, in order for the confidence
assessments to be
directionally accurate. A range of values on a year by year basis (or other
time period) may be
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CA 02540003 2006-03-22
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provided within which the goals of the client can be reasonably confident of
exceeding such
goals, yet avoiding undue sacrifice or excessive compromise to the goals can
be calculated. If
the value of the portfolio falls outside this range, then the recommendation
should be reviewed.
Similarly, if background information changes, if goals are added or deleted,
or if ideal or
acceptable values of goals change or the relative weight of goals change, then
the .
recommendation should be reviewed.
[00070] The method of providing advice, including the steps of obtaining
background
information the client, identifying a set of client goals, identifying ideal
and acceptable values for
each goal, and identifying relative weighting of the various goals, and
designing a
recommendation with results for each goal not better than the ideal value and
not worse than the
acceptable value, may be applied using a variety of techniques of measuring
the confidence and
or likelihood of various outcomes. In one preferred embodiment, the technique
of using a Monte
Carlo based model of capital markets, properly considering. the market's
uncertainty and
behavior in random time periods and specifically not ignoring the risk of
active investments
potential risk of material underperformance is assessed and can be used in the
development, and
in the future assessment of the confidence of a recommendation, even if the
recommendation is
not developed and reviewed using the goal-based methods set forth above.
(00071] The present invention can be embodied in the form of methods and
apparatus for
'. : 'practicing those rrietliods:'The'preserit invention can also~be
embodied~iri the.forni of program
code embodied in tangible media, such as floppy diskettes, CD-ROMs, hard
drives,.or anyother
machine-readable storage medium, wherein; vcyhen the program code is .loaded
into and executed
by a machine, such as a computer, the machine~becomes an apparatus for
practicing the
invention. The present invention can also be embodied in the form of program
code, for
example, whether stored in a storage medium, loaded into andlor executed by a
machine, or
transmitted over some transmission medium, such as over electrical wiring or
cabling, through
fiber optics, or via electromagnetic radiation, wherein, .when the program
code is loaded into and
executed by a machine, such as a computer, the machine becomes an apparatus
for practicing the
invention. When implemented on a general-purpose processor, the program code
segments
combine with the processor to provide a unique device that operates
analogously to specific logic
circuits.
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[00072] While the invention has been described with reference to preferred
embodiments,
the invention should not be regarded as limited to preferred embodiments, but
to include
variations within the spirit and scope of the invention.
2s
